In Stanziale v. Sprint Corp. (In re Simplexity, LLC), 578 B.R. 255 (Bankr. D. Del. 2017), Delaware Bankruptcy Judge Kevin Gross addressed an issue of first impression: which was the proper date for determining the secured status of a creditor in a preference dispute under 11 U.S.C. § 547(b)(5), the petition date or the transfer date? Ultimately, Judge Gross decided that the petition date was most proper, at least with respect to creditors secured by a purchase money security interest (“PMSI”). Nevertheless, this aspect of the analysis under section 547(b)(5) remains highly fact-specific.
The Debtors, formerly independent online activators of mobile phones, filed for bankruptcy protection under Chapter 11 on March 16, 2014. Prior to that time, the Debtors and Defendant were parties to an agreement that let the Debtors solicit and subscribe customers to Defendant; to that end, the Debtors could either purchase products from Defendant and resell them to customers, or sell products directly from Defendant’s inventory. Defendant received a PMSI in products the Debtors purchased on credit and proceeds from the sale of such products. Following conversion to Chapter 7, the Chapter 7 Trustee (the “Trustee”) initiated the instant adversary proceeding to recover these payments to Defendant; the parties’ motions for summary judgment ultimately followed, raising section 547(b)(5) and subsequent new value arguments.
Must a preference defendant be secured on the transfer date or the petition date for section 547(b)(5) purposes?
In light of the PMSI, Defendant argued that the Trustee could not satisfy his burden under section 547(b)(5)’s hypothetical liquidation test. The Trustee first countered that the burden was not on him to do so in this instance; rather, Defendant had to prove it was truly secured given its reliance upon state law. The Court rejected this reasoning based upon the plain language of section 547(g) (placing the burden on the Trustee to establish the elements under section 547(b)).
The Court next addressed the issue of first impression referenced above and incidentally, one that had created a split among courts which had considered it—is secured status assessed at the time of the transfer or the petition date? Defendant argued that it was entirely secured, notwithstanding that the Debtors kept their funds in commingled accounts which were swept only a few days prepetition. Further, Defendant argued that a Supreme Court decision which had determined the petition date to be the proper date of reference (Palmer Clay Products Co. v. Brown, 297 U.S. 227 (1936)) was misplaced in the context of a secured creditor, as that case had been dealing with an unsecured creditor. Thus, with that in mind and in reliance upon a decision by Delaware Bankruptcy Judge Peter Walsh (Forman v. IPFS Corp. of the South (In re Alabama Aircraft Indus.), 2013 WL 6332688 (Bankr. D. Del. Dec. 5, 2013) (holding the transfer date to be the proper one for assessing preference liability of a creditor pursuant to an insurance premium financing agreement), Defendant argued that the transfer date controlled.
The Court disagreed, finding the fact-specific distinctions in Defendant’s “transfer date” cases and the instant case to be determinative; i.e., the Court distinguished between a PMSI case and cases dealing with premium financing arrangements or cases with liens of diminishing value. This was so because a PMSI is a decidedly limited and better defined interest compared to a floating lien; moreover, the collateral at issue here (headsets and proceeds from selling the same) was unlikely to undergo stark changes in valuation. Thus, while the Court envisioned a factual scenario that may warrant deviating from the petition date analysis, the instant case did not contain such facts. The PMSI vs. floating lien distinction likewise underpinned the Court’s holding on the propriety of the Trustee’s tracing method—i.e., the “add-back” method, used for determining a defendant’s position on the petition date in a hypothetical liquidation.
Does an earlier-than-usual payment by a preference defendant to a debtor constitute subsequent new value?
The Court also ruled upon part of Defendant’s subsequent new value argument under section 547(c)(4). Specifically, Defendant argued that a payment it made to the Debtors two days before the petition date qualified as subsequent new value, as it was commission money not yet owed to the Debtors under any of their agreements; ergo, it augmented the estate. The Trustee opposed this defense on the grounds that it was a seemingly random payment made in Defendant’s capacity as a debtor, not a creditor, and that in any event, Defendant merely substituted one asset of the Debtor for another (i.e. an A/R for cash). To the latter point, Defendant argued that the Trustee ignored the fact that Defendant would never have paid the A/R due to Defendant’s rights under various agreements and section 553 (setoff).
The Court agreed with Defendant, finding the issue centered around determining the purposes of Defendant’s payment. To that end, Judge Gross found that the underlying agreements and the parties’ course of dealing demonstrated that Defendant’s commission payments to the Debtors were due at the end of the month, whereas the instant payment was made mid-month; as such, Defendant was not yet a debtor, nor were the Debtors creditors of Defendant.
Furthermore, the Court found that Defendant did not merely substitute Debtor’s A/R for cash. For one thing, the commission payment was an (out of the ordinary) advance, not a regularly scheduled payment. For another, the A/R would have been uncollectable for the reasons argued by Defendant. At bottom, Judge Gross found Defendant’s commission payment personified section 547(c)(4)—a “beacon of light in a dark time” that decisively enhanced the Debtors’ estate.
The Court’s opinion in Simplexity sheds light on how the analysis under section 547(b)(5) changes where a creditor is secured. Particularly, the Court makes clear that the type of security interest at play will likely impact the Court’s analysis. In that sense, the Court seemingly harmonized its opinion here with earlier, seemingly conflicting decisions, including those from the same jurisdiction. Perhaps the greater point, however, is that these analyses will remain highly contextual determinations.
The opinion also provides support for interesting subsequent new value arguments, and incidentally, strategic considerations for defendants dealing bilaterally (i.e., relationships where the defendant may be acting as both a creditor and a debtor at times) with companies on the verge of bankruptcy. Specifically, making a payment earlier than contractually obligated can inure to Defendant’s benefit, as the advance potentially prevents the creation of an A/R—and concurrently may prevent the bankrupt company becoming a creditor of the defendant. This argument becomes stronger if the defendant likewise maintains setoff rights, as Defendant did here.